The Nobel prize for economics was handed today to three academics who argue that governments need to cut benefits and tackle restrictive practices and regulations in the labour market to boost employment levels.

The British academic Christopher Pissarides of the London School of Economics took the 10m Swedish kronor (£950,000) prize along with his American colleagues Peter Diamond of MIT and Dale Mortensen of Northwestern University for their work on unemployment and the labour market.

Their analysis of why unemployment remains high when jobs are available has found favour with governments attempting to create a more flexible environment for employers. One of their conclusions is that more generous unemployment benefits give rise to higher unemployment and longer search times.

The citation said the laureates had developed a "theoretical framework for search markets that has gained widespread influence".

The academy said: "Peter Diamond has analysed the foundations of search markets. Dale Mortensen and Christopher Pissarides have expanded the theory and have applied it to the labour market. The laureates' models help us understand the ways in which unemployment, job vacancies, and wages are affected by regulation and economic policy."

Pissarides, 62, a British Cypriot, has spent several years analysing European labour markets during a period when continental governments have sought to replicate the flexible labour markets in the US and UK. He has advised the European Union on employment policy and has written extensively in professional journals. His book Equilibrium Unemployment Theory is a standard reference in the economics of unemployment.

Diamond, 70, who was nominated in April by Barack Obama to fill a vacancy on the US Federal Reserve board, is known as the father of matching theory. His initial nomination was blocked by Republican senators who said that he did not have the necessary macroeconomic policy background.

In recent years the theory has been applied to job searches and whether high benefit levels and unemployment insurance, along with restrictions on hiring and firing employees, have hampered flexible labour markets. The research is particularly relevant now when looming drastic government spending cuts in Britain will lead to thousands of job losses in the public sector.

"The prize is for work on frictions in markets, which is very important stuff; but Peter, an incredibly profound thinker, has done much, much more. And yes, this is the same Peter Diamond whose nomination to the Fed board has been held up because of Republican doubts about his qualifications."

The Nobel prize committee said: "According to a classical view of the market, buyers and sellers find one another immediately, without cost, and have perfect information about the prices of all goods and services ... But this is not what happens in the real world."

It said the trio's work enhanced understanding of "search markets" where frictions exist as the demands of some buyers are not met and some sellers cannot sell as much as they want.

This could involve simple cases of a buyer and a seller of a product, as well as more complex relations between employers and job seekers, or between firms and suppliers.

The economics prize is not among the original awards established by the Swedish industrialist Alfred Nobel in his 1895 will but was created in 1968 by the Swedish central bank in his memory.

Since the economics prize was first awarded in 1969, more than 40 Americans have received it. Laureates include the former chief economist of the World Bank Joseph Stiglitz, and the Indian economist Amartya Sen, professor of economics and philosophy at Harvard.